Financial Constraints and the Real Effects of Monetary Stabilization Policies Under Alternative Exchange Rate Regimes
34 Pages Posted: 15 Feb 2006
Date Written: October 2, 1987
Abstract
A common argument against monetary stabilization policies in developing countries is that they lead to short-run output contractions. This paper shows that, in economies facing financial constraints, such results only need to hold in a fixed exchange rate system. Under flexible exchange rates, reductions in the nominal stock of money will be contractionary only if they are temporary. Permanent decreases in the stock of money will leave output unchanged or might even be expansionary. These conclusions will be valid, however, only if the stabilization policies are fully announced and followed by the governments in those economies.
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